Real Estate Lending: Finding Funding – Private Money Lenders & The Self-directed IRA/401k

October 25, 2014

At this point in our “Finding Funding” journey, we have already briefly discussed the many different avenues of funding for real estate investors. We’ve discussed hard money lenders, lines of credit, credit cards, and cash.

Today, I’d like to cover two more funding options:
Private Money Lenders (PML)
Self-Directed IRA/401k (SDIRA)
PRIVATE MONEY LENDER: (PML)

PML’s are the most lucrative avenues of funding that you can find. The next questions is, “why?” It’ simple – PML’s provide you the easiest and most profitable payment terms. However, they are typically difficult to locate and even if you do, you need a lot of experience under your belt just to reel one in.

Every beginner investor that I know, including myself, make mistakes over the course of their first few flips. It is, in my opinion, the best way to learn – from our mistakes. One of the biggest mistakes that beginner investors make in their attempt to locate a good funding route is by spending far too much time attempting to locate a solid PML. However, in almost every single case, a PML is not going to loan capital to a new, untested, unproven real estate investor. And most PML’s that I know aren’t even lending all that much in real estate anyway. These are sometimes family friends, family members, doctor or attorney friends, or an affluent person in your direct circle of peers.

But let’s just say you have contacted someone who is willing to loan private funds to real estate investor. However, he is concerned that you do not have any flips under your belt. Again, PML’s likely won’t loan to an investor who’s never completed a flip. You’ve got no experience yet you’re asking for a whole lot of money. But you don’t yet specialize in flipping and he doesn’t specialize in funding – this is a recipe for disaster! This is a good time to use another funding source (HML, LOC, CC, etc) and complete your first flip. You’ll get that PML once you’ve proved yourself. The advantages of a PML loan are awesome –

No points
Low interest: 10-12%
No monthly payments until the deal closes

I’ve seen situations in which private money lending has separated families and ruined relationships. Maybe your uncle wanted to help out and loaned you $100,000. But the flip turns sour, the house won’t sell, and you’re losing money. At this point, you’re uncle has to take over the project. This obviously causes immediate strife. Get some experience under your belt and then go after that PML with a proven portfolio. Don’t start out looking for private money. It’ll likely not pan out for you and will be a waste of your precious time.

SELF-DIRECTED IRA/401K: (SDIRA)

There is more money available here for rehabbers than anywhere else you can go. There’s billions, possibly trillions of dollars accessible to the right investor. SDIRA’s can be difficult to locate, but once you do, you can find some very eager lenders!

A SDIRA is someone’s personal retirement account. SDIRA account holders have control over and can direct where their money is invested. Many SDIRA’s invest large amounts of money in real estate. Much of the capital loaned from private lenders comes from a SDIRA or 401K. The “rub” is that the account holder cannot do business with family, by law. They also cannot be the person that actually flips the house if their SDIRA monies are being used. So, they’re typically looking for someone to lend-to and to flip for them. Being that SDIRA account holders cannot loan to family or flip using their SDIRA monies, we call this an “arms-length transaction.”

But the process of using a self-directed IRA to jump into investing in real estate requires preparation and caution. Here are five things to keep in mind when considering investing in real estate through a self-directed IRA:

It takes time – be patient
You cannot take advantage of IRA investments until you retire
Your spouse, immediate families or companies you have a 50% interest in cannot be involved
It takes a lot of work
All income from the property is tax deferred